Investor's Eye: Update - Mcleod Russel India (Downgraded to Hold; price target revised to Rs356), Deepak Fertilisers & Petrochemicals Corporation (Annual report review)

   

Investor's Eye [September 13, 2012]  Sharekhan www.sharekhan.com

Summary of Contents STOCK UPDATE   Mcleod Russel India Cluster: Ugly Duckling Recommendation: Hold Price target: Rs356 Current market price: Rs329 Downgraded to Hold; price target revised to Rs356  Key points FY2012 performance-high input cost affected stand-alone business' margins: Mcleod Russel India Ltd (MCRL)'s consolidated revenues grew at a steady rate of 14.1% year on year (YoY) to Rs1,412 crore in FY2012 driven by a mix of volume growth (~7%) and higher blended realisation (also up 7%). However, the consolidated operating profit margin (OPM) declined by 137 basis points to 25.2% in FY2012, largely due to pressure on the stand-alone OPM (down 353 basis points to 22.5%). The company has increased the purchase of tea from the other gardens to drive its sales volume. This resulted in a higher raw material cost which affected the stand-alone OPM. Despite the pressure on the margin of the Indian operations, the higher margins in the overseas operations and a lower effective tax rate resulted in a 22% growth in the adjusted profit after tax (PAT) to Rs302.9 crore. The highlights of the fiscal were a strong 22% growth in exports (33% of the stand-alone sales) and the margin performance of the Ugandan and Rwandan subsidiaries whose EBIT margin stood at 37.5% and 53.6% respectively in FY2012 (significantly ahead of the consolidated OPM of around 25%). Operating cash cycle increased to 15 days: MCRL's operating cash cycle stood at 15 days in FY2012 as against negative three days in FY2011. This was largely on account of a decline in the creditor days to 25 days in FY2012 from 38 days in FY2011.  Consolidated debt reduced by over Rs50 crore: MCRL maintained its thrust on reducing debt at the consolidated level. In FY2012 the consolidated debt was reduced by Rs53.2 crore largely through the incremental cash generated at the operating level (which increased by almost Rs40 crore in FY2012). The improvement in the profitability over the years has aided MCRL to post a strong improvement in the operating cash flows. On the back of improved (operating) cash flows the company was able to reduce the consolidated debt from Rs457.0 crore in FY2008 to Rs263.1 crore in FY2012. The company's interest coverage ratio improved from 1.6x in FY2008 to 11.2x in FY2012. Return ratios sustained in high teens: MCRL's return ratios sustained in high teens in FY2012. The return on equity (RoE) and return on capital employed (RoCE) stood at 18.6% and 18.5% in FY2012 as against 17.3% and 18.4% in FY2011 respectively. Dividend pay-out ratio stood at ~23%: The company maintained its steady dividend payment record with a dividend payment of Rs6 per share (a dividend yield of 1.8%). The dividend pay-out ratio has improved from 19.0% in FY2010 to about 23% in FY2012. With the profitability expected to improve, the dividend pay-out ratio is likely to improve in the coming years. Outlook and valuations: We have fine-tuned our earnings estimates for FY2013 and FY2014 after incorporating the numbers of the FY2012 annual report and subsidiaries in our financial model. Though lower tea production might lead to a flat sales volume, but we expect the higher anticipated sales realisation to boost the top line growth and the margins in FY2013. However, any significant drop in tea production for MCRL might act as a key risk to our earnings estimates. At the current market price the stock is trading at 10.5x its FY2013E earnings per share (EPS) of Rs31.5 and 8.3x its FY2014E EPS of Rs39.5. The fine-tuning of the earnings estimates has led to a revision in the price target, which now stands at Rs356 (the price target values the stock 9x its FY2014E EPS of Rs39.5). However, due to limited upside from the current levels, we downgrade the recommendation on the stock from Buy to Hold. Any substantial improvement in the profitability in the coming quarters would act as a key trigger for the stock.   Deepak Fertilisers & Petrochemicals Corporation Cluster: Ugly Duckling Recommendation: Buy Price target: Rs179 Current market price: Rs128 Annual report review  Key points Robust revenue growth but margins disappoint in FY2012: Deepak Fertiliser and Petrochemicals Corporation (Deepak Fertiliser) reported a robust revenue growth of 49.7% year on year (YoY) to Rs2,342.8 crore in FY2012, largely driven by a surge of 83.1% in the revenues from the fertiliser segment to Rs969 crore. The fertiliser segment's strong performance was driven by a higher production of nitro-phosphate fertilisers (NP; a volume growth of 42%) due to the better availability of phosphoric acid and the introduction of new variants of NP (like 24:24:0). The revenues generated from trading of fertilisers also surged by 75% to Rs475.3 crore in FY2012. However, the operating profit margin (OPM) plummeted by 500 basis points to 17.1% due to a steep jump in the cost of inputs (ammonia and propylene).  Increase in debtor days affect working capital cycle: During the fiscal the cash flows from operations after working capital adjustments declined to Rs102.1 crore in FY2012 as compared with Rs227.4 crore in FY2011 largely due to an increase in the inventory and receivables days. However, we understand that the inventory and receivables were higher mainly on account of higher inventory build-up in Q4FY2012 ahead of a reduction in the non-urea subsidy pay-out by the government in FY2013.  Return ratios remain stable: The return ratios remained stable with the return on equity (RoE) and the return on capital employed (RoCE) at 13% and 18.5% in FY2012 as compared with 12.0% and 18.7% in FY2011 respectively.  Outlook: In this fiscal, the fertiliser segment may see some contraction in volume (both manufacturing and trading) mainly because of a lower offtake of non-urea fertilisers due to an increase in the price and a delayed monsoon. On the chemical side, the margins are expected to stablise with the ammonia prices likely to stay in the range of $650-700/tonne due to the expected commissioning of new capacities globally towards the end of the year.  Valuation and outlook-retain Buy with price target of Rs179: At the current market price the valuation looks supportive and attractive. So we maintain our Buy rating on the stock with a price target of Rs179. Moreover, the stock offers a decent dividend yield (a dividend of 55% or Rs5.5/share in FY2012). At the current market price of Rs128, the stock trades at very attractive valuations of 4.9 and 4.3x its FY2013E and FY2014E earnings respectively. Click here to read report: Investor's Eye Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a postition in the companies mentioned in the article.

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